Consider these 9 things before investing in mutual funds!

There has been an ongoing discussion on inflation and its likely return across the globe. In India, inflation rate has been higher than the average over the last five years. Recently, the WPI came at 10%, which further sparked speculation about this feeding into CPI inflation.

For an average consumer, it is the CPI Inflation which is important as the CPI is constructed on the basis of the basket of consumption of an average household. That is, if CPI inflation is 5, then the average consumer will see their cost of purchasing their consumption basket increase by 5%. WPI on the other hand is of interest to producers as it typically tracks the input prices. Thus, the conventional logic is that an increase in WPI inflation implies an increasing cost for manufacturers, which will be reflected in the CPI figures eventually.

What to expect?

The question that many have is whether their consumption basket will indeed cost more. This is important as many have experienced nominal wage cuts over the last one year as companies slashed salaries while others retrenched workers. There are several important aspects here that must be adequately discussed – but the short answer is that I expect inflation to remain rather well-behaved – that is, between 3.5-5.5% for the current financial year.

The recent hike in inflation, primarily of CPI, was largely driven by supply related disruptions. While some of these disruptions are still at play due to the ongoing second wave of the pandemic, but once they are addressed, we should see inflationary impulses get muted. Perhaps, the real risk could also be too low inflation as an outcome of a weaker demand as people shore up their savings and build adequate buffers to deal with any form of economic shock in the future. As is the case, it has been seen that post the Spanish-Flu, there was an increase in precautionary savings.

Relief in sight for Aam Aadmi?

Therefore, there is limited evidence to suggest that there could be sustained pressure on the demand front, which may lead to inflationary impulses in the economy. So as supply disruptions get addressed, inflation would begin to moderate. Thus, an average consumer may not have to spend more on consumption budget.

Many would point at the increase in commodities prices over the last few months – including the WPI print coming at double digits. Their argument is that an increase in commodity inflation would find its way to hurt the pockets of Aam Aadmi over the next few months. However, there are two factors at play here. Let us begin with the first, which pertains to the WPI figures. WPI Inflation, if one looks on a month – to – month basis was not 10 per cent but 2 per cent. Seasonally adjust this to take out any seasonal factors and you still won’t get a high inflation print.

So, then why is WPI at 10.49% in April? For starters, commodity prices crashed in April 2020 and we all remember the extensive commentary on moderation in oil prices back then. Therefore, it was only natural for the WPI print to come out higher as prices begin to reach to the previous figures. This of course does not imply high inflation, as the underlying items in WPI are simply reverting to their previous highs. Further, do note that inflation in food articles was 4.92% in April and a major reason behind this was the increase in prices of protein rich items such as eggs, meat and fish.

The second issue pertains to some commodities that have indeed witnessed an increase in their prices. This is with regards to the stock and flow concept. For instance, let us take the example of lumber, prices of which have increased in the US. A major reason for this was that the record stimulus checks had overheated the supply for fresh houses. Houses in US are constructed using wood instead of bricks as in India. As an outcome of this renewed demand for housing, renovation, etc, the supply (or rather the flow of lumber) could not catch up instantaneously. This in turn has driven up the prices of lumber in the US. Similarly, for a lot of the commodities, we could expect the record levels of stimulus to imply an increase in prices. However, this increase in prices will be transitionary as any such sustained increase would result in companies adjusting the flow of the commodities (that is, they will extract them faster) which would ensure adequate supplies thereby easing any price pressures. That this entire adjustment process will take two to three quarters is well recognised by central banks such as the Reserve Bank of India or the US Federal Reserve.

Moderation soon

It is hard to imagine a scenario whereby there is sustained inflationary impulses in the economy while it has witnessed nominal wage cuts and some level of permanent loss of inflation. In all likelihood, inflationary impulses would moderate, as they have with regards to the CPI over the last few months. Thus, it is safe to assume that ultimately, households will be back to experiencing a 4-5% inflation rate over the coming few months, which has been the norm over the last five years.

(The writer is an economist and policy-researcher. Views expressed are personal)